Graduate School of International Relations and Pacific Studies (IR/PS)

The Transformation of the State Sector: SASAC, State-owned Business: Adapting to the Market Economy and the new Nurturing National Champions

Barry Naughton

Graduate School of International Relations and Pacific Studies (IR/PS)

University of California, San Diego

La Jolla, CA 92093-0519

Paper presented to the International Colloquium, “Business and the Chinese Miracle,” Bocconi University, October 16-18, Milan, Italy. Preliminary draft. Comments and criticisms welcome.

The restructuring of China’s state-owned enterprises has been at the core A central component of China’s transition from state socialism to state capitalism has been the restructuring of state-owned enterprises. The long term trends are very clear: SinceDuring the last 15 years, from 1993 to 2008, the Chinese state sector has shrunk dramatically; Chinese state-owned firms have predominantly become market-oriented entities; experiencedand the state sector as a whole has undergone a have gone through a definitive phase of transformation. However, it is also clear that the state sector has been stabilized and will now persist for the foreseeable future: further downsizing—to say nothing of privatization—is not in prospect. , the outlines of which are just now becoming clear. Nearly all firms have gone through a common transformation process that includes the adoption of a corporate organizationIn retrospect, the year 2003 emerges as a crucial turning point, with institutional consolidation after which the central state sector stabilized and even began to grow modestly. Moreover, since 2003, the characteristics of the state sector changed. The result has been the emergence of a distinctive Chinese industrial system, which we might call “state capitalism” or “centrally-managed capitalism.” In this system, the large centrally-owned firms now operate in a market environment, but they remain privileged actors, benefiting from special treatment and partially protected markets. This combined system—genuine restructuring plus government protection and support—has been accompanied by a return to robust profitability by central state enterprises. As a result, the Chinese political leadership, which in the 1990s viewed the SOEs as a problem to be fixed, now ; in turn, this organizational structure allows the firms a greater measure of diversity in their strategies and business models. Thus, a common transition process has resulted in a more diverse firm ecology. The purpose of this paper chapter is to sketch the common features of the process and point to some of the main outcomes. By As the second decade of the twenty-first century, draws to a close, most state firms hadve been restructured and they are undergoing a renaissance that few predicted ten years ago. Iincreasingly, the Chinese government views these firms as instruments that can help in the achievement of national goals, rather than as a problem to be fixed.

This chaptpaper focuses on the firms controlled by the central government, and particularly those directly under the central State Asset Supervision and Administration Commission, or SASAC. TTthe establishment of SASAC in 2003 punctuates the transformation process: it, and marks the end of the most dramatic change, ands the beginning of a phase of greater institutional stabilitystate sector consolidation. The first part of this chapter describes the 2003 establishment of SASAC, and its initial mission. It evaluates the successes and failures of SASAC’s mission, and the changes in the nature of the state sector that have accompanied, and to some extent resulted from, SASAC’s efforts. The state sector, we will show, has become much more centralized and dominated by a few large firms. SASAC has been quite successful in stabilizing these large firms and returning them to profitability. It has been much less successful in transforming the institutional structures, and there has been some backsliding in recent years. Indeed, it is possible to speak of the defeat of some aspects of the original SASAC agenda. Second, the chapter examines the extent to which new “national champions” have emerged among central government firms, and the particular missions with which these national champions have been endowed. No further privatization is in sight, even dimly on the horizon. The wave of privatization that has washed over the Chinese economy in the past thirty years now laps peacefully on the shores of this giant island of public ownership. Central SASAC firms have developed into a powerful and profitable economic force, representing the core of state capitalism in China.

The first half of the chpapter describes the new institutional set-up of the Chinese state economy, and the dynamic—but slow and costly--process that created the current system. The second half of the paper examines the extent to which the central government firms are becoming the “national champions” of an emergent China.

1.Creation of the SASAC a New Institutional Set-upSystem

The creation of SASAC in early 2003 was a milestone—and in some respects a turning point—in the process of economic reform. SASAC wasis established as an authoritative “ownership agency,” empowered to exercise the government’s ownership rights over government firms. Its establishment marked a turning point in two respects. TFirst, the creation of SASAC marked the end of a period of creative destruction, in which the main thrust of state enterprise reform had been the disruption of protected bureaucratic relationships and the dramatic down-sizing of the state sector. State enterprise employment dropped from 76 million at its peak in 1992 to just under 4350 million in 20025, before stabilizing.[1] (including all workers in state-controlled corporations[KT1]). From 1996 through 2002, the total stock of urban unemployed (laid-off workers plus registered unemployed) remained high (over 14 million), only declining after 2002[KT2]. Immediately before SASAC was n fact, the establishedment of SASAC, ended a period of five years during which most central government state firms really had had been operating without a real no owner for almost five years, since at all. In 1998, Premier Zhu Rongji had had abolished most of the industrial ministries in 1998. and with them the weak (and failed) State Asset Management Bureau which had had responsibility for an accounting style of oversight for state firms. State firms simply carried on as before, embedded in functioned without an “owner”: a web of interests and traditional bureaucratic relationships, with weakaccounting-style oversight exercised by an impotent “State Assets Management Bureau.” kept firms on track—or stuck in a rut—most of the time. The creation of SASAC as an ownership agency with clear powers was part of an effort to enabled continuing change more dramatic and more systematic changes restructuring within the state sector.

At the same time, it marked the end of overall downsizing and privatization within the central government sphere.

Upon creation, Second, SASAC—established initially at the central government level— was given ownership of a specified list of 196 corporations. Crucially, this meant that Ccentral SASAC had therefore didnothave any ownership claim on the thousands of other state-owned companies (or, including onon any banks or other financial companies.) For the first time, Some firms, to be sure, were still owned by ministries, and ownership of banks and other financial institutions was gradually consolidated under a new agency, the Huijin Corporation. But tthe vast majority of state firms were henceforth fully “owned” by the local governments (which gradually set up their own “local SASACs”). The localities had, of course, that had been managing them in the state’s name for decades, but the unambiguous grant of ownership rights meant. That gave that local governments now hadgreaterthe freedom to restructure and privatize firms, and transform their industrial sectors without being paralyzed by the web of conflicting national and local interests and policies. Meanwhile, government ownership of banks and other financial institutions was gradually consolidated under a different new agency, the Huijin Corporation. SASAC’s clarified ownership over some state firms was designed to allow the restructuring and privatization of other smaller, local firms to be carried out more smoothly and rapidly (a theme we will see repeated in SASAC’s history).

As for those firms that it owned directly, central SASAC was poised to carry out a two-stranded agenda: dramatically improve corporate governance and restructure state-owned firms so that they were concentrated in sectors in which they had some comparative advantage and there was an economic justification for continued state ownership. Before we examine the success and failure of SASAC’s agenda, it makes sense to review the overall changes in ownership structure and performance that took place during the period after SASAC’s establishment. Figure 1 shows how SASAC’s establishment corresponded with the stabilization of the state sector. Examining the case of industrial workers (the largest single category and the one with the best comparative data), Figure 1 shows that state industry workers declined rapidly until 2003 (the year of SASAC’s creation), dropping to 21 million in that year. The following year, state industrial workers dropped below 20 million but thereafter stabilized at around 18 million, even increasing slightly after 2008. State sector stabilization needs to be put into context, though: overall industrial employment dropped until 2001, and then began to grow robustly from 2003. Thus, even when state sector employment stabilized, it continued to fall as a share of total industrial employment and after 2008 amounted to about 20% of industrial employment.[2]

While the overall state sector shrank, SASAC’s subordinate enterprises continued to grow. Tables 1 and 2 compare 2002 and 200[KT3]8, showing that central SASAC grew both the number of workers and the total value of assets. Total employees in SASAC firms grew by almost 3 million, from 8.6 to 11.4 million; and SASAC assets more than doubled (without accounting for inflation). The growth of SASAC firms implied striking changes in the relative position of central SASAC. Local state firms continued to shrink and shed workers over this period. Focusing on industrial workers, local state firms had over 18 million workers in 2002; by 2008, this had declined to 10.2 million (SASAC Yearbook, 2009: 710). Thus, the apparent stabilization of the state industrial labor force conceals a continuing gradual shrinkage of local state industry, combined with an ongoing gradual increase in the size of central SASAC firms. Increasingly, the state sector is dominated by large, centrally-controlled firms. For decades, the overwhelming majority of state industrial workers have worked in local government firms; by 2008, this had dropped to 55%. Central SASAC firms now account for 41% of state industrial enterprise workers (up from 24% in 2002). Moreover, since SASAC firms are much more capital-intensive than other parts of China’s public economy, SASAC now accounts for 56% of state industry assets. Central state industry has nearly 8 million workers, concentrated in large firms; local state industry has more workers (10.2 million), but these are in smaller firms that only make up about 15% of industrial employment at the local level.

The profitability of SASAC firms has rebounded strongly since SASAC was set up. Back in the 1990s, the entire state enterprise sector, in aggregate, produced essentially zero profits. State enterprise profitability has recovered significantly since that time: most loss-making firms were shut down; surviving firms shed millions of redundant workers; and firm management improved significantly. State industry today is much smaller than it was in the 1990s, but much more profitable. SASAC firms have been an important part of this transformation. SASAC firm profits soared to just shy of 1 trillion RMB in 2007, increasing from 2% of GDP in 2002 to 3.8% of GDP, as shown in Figure 2. (For comparison, ExxonMobil’s record $40.6 billion profit in 2007 was equal to 0.2% of US GDP). With substantial sums of money at their disposal, SASAC firms have financial clout that reinforces their economic importance. Indeed, the wealth of these large firms became a public issue in China in the wake of the publication of the eye-watering 2007 figures. In the event, the arrival of the global financial crisis a few months later dealt a major blow to SASAC firm profitability. When, after 2009, profits began to recover and it became clear that the prominent financial position of these firms had not fundamentally changed, SASAC switched from reporting gross profits to reporting a more moderate-looking net profit (deducting profit taxes and other remittances to the government). Despite these accounting tricks, it is quite clear that the main SASAC firms continue to dispose of enormous financial resources.

[KT4]SASAC firm profitability is highly concentrated. In 2006, nine firms contributed 69% of total SASAC profits; in 2008, the top nine contributed 64%; and in 2009, 72%. Seven firms were in this elite list in each year: the three big oil companies; the two top telecom firms, and Baoshan Steel and Shenhua Coal.[3] The most profitable firms—those in petroleum and telecom—operate in protected markets that keep profit margins fat. A key feature of China’s state firm strategy coming out of the 1990s was the creation of limited competition in most crucial markets. The three oil firms have different areas of concentration but also compete as potentially integrated firms; three telecom companies compete with mobile services; and even the five main military industries were split into two potentially competing companies. Thus, the SASAC firms do not have absolute monopolies, but they have substantial market power, and there are virtually insurmountable barriers to new firm entry in most cases. Thus, SASAC profitability is significantly due to the protected markets in which these firms operate. At the same time, there is no doubt that these flagship firms are much better managed than before. In the next chapter, Doug Guthrie, Zhixing Xiao, and Junmin Wang find that the performance of SASAC’s listed firms is indeed stronger than traditional SOEs. The top firms are the elite club of the SASAC group, and it is from this group that most of China’s national champions are likely to be drawn.

A focus on the biggest SASAC enterprises is certainly justified, but it could alsoYet, to say that central SASAC owned exactly 196 corporations can also give a be misleading. Most of the big enterprises directly under SASAC are in fact sense of the central state enterprise complex, as well as of the complicated and drawn-out process of transformation. In fact, these 196 corporations were umbrella organizations that own and run including many subsidiary more state companies. Figure 3 provides an overall view of the state enterprise sector in 2008, which permits both a broader and a more precise picture. By the end of 2008, the top SASAC firms had been reduced to 142, after several rounds of consolidation. But the total number of companies subordinate to SASAC was a remarkable 17,638. The average top level SASAC firm—which probably evolved from a former ministry—had more than 120 subsidiaries, sometimes Each of the large corporations directly owned by SASAC was itself typically the owner of multiple subsidiaries, sometimes indeed hundreds of subsidiaries organized in two or three layers of companies. Figure 3 also shows that there is still a significant central government enterprise sector outside of SASAC, including, for instance, the railways. These are less important in industry, but still significant in transport and a range of social services (financial firms are not included in this Figure). When it was established, in In 2003, SASAC did not even knowhow many totalthe number of companiesof which it was in charge of, nor the value of the assets they were supposed to manage[KT5]. Over the next few years, one of SASAC’s main activities was discovering assets and clarifying ownership relations, while also consolidating and restructuring firms. resulting in the data we show in Figure 3.

It is useful to think of the central state sector as a gigantic pyramid. The pyramid is being transformed by a long and drawn-out process of change, some of (the main features of which are described in the following section). The formerWhat was once a bureaucratic edifice has not been completely dismantled, but it has now been incompletely transformednow more closely resembles intoa network of businesses. The largest firms sit at the top of the economy, with their near-monopolies giving them a privileged position. But other SASAC firms, and the thousands of subsidiaries of these firms, inter-mingle with other levels in what—which Margaret Pearson, in her chapter, describes in her chapter as a “tiered” economy. As a firstapproximation, it is useful to think of the central enterprise pyramid as being relatively market-oriented at the top and at the bottom. Presiding over At the top of the pyramid, SASAC has advanced a vision in which the of a publicly-owned sector would be gradually transformed into a system where all firms are converted into joint stock companies, managed efficiently, and controlled by their owner where firms are managed through capital market operations processes, much as a sovereign wealth fund manages its investments. At the bottom of the pyramid, many of the best enterprises have been thoroughly restructured into market-oriented corporations, and quite a few thrive in the face of vigorous competition. However, the transformation process still has much to accomplish in the least-reformed “middle layertier.” In this middlee middle layer, a tangle of competing interests mixes bureaucratic recalcitrance, agency loss, lack of transparency, and stubborn problems that have been swept under the rug. SASAC seeks to gain and retain control over this realm, and also to rationalize and modernize its holdings in accordance with a modern economy. To penetrate further into the situation in the middle layer, it is necessary to examine the dynamic processes of institutional reform carried out under SASAC’s auspices. As mentioned above, SASAC pursued a two-stranded agenda of improving corporate governance and restructuring the state sector. Immediately under SASAC are the peak corporations, most of them evolved from former ministerial bureaucracies. We can now piece together a fairly precise picture of this pyramid as of the end of 2006 (See Figure 1).[4] The number of peak firms directly under SASAC had declined to 161 (and would decline further to 12249 by July 20108), but the total number of firms of all kinds, including all subsidiaries, was a whopping 16,373, more than 100 subsidiaries per peak firm. Moreover, this empire included 11 million employees and assets worth 12.2 trillion RMB (about $1.5 trillion). After more than thirty years of reform, the central state sector in China not only remainsis intact, but big and, as we shall see, continues to growing, both directly and indirectly through new organizational forms in the private sector.